When discussing crypto trading with experienced traders, the topic of perpetual futures, or 'perps,' inevitably comes up. These derivatives contracts allow traders to control large positions with minimal capital, and their popularity stems from their unique advantages over traditional futures. Unlike standard futures, perps do not have an expiry date, making them a crucial tool for traders seeking to manage risk efficiently. In fact, for many altcoins, perps are the only viable option for derivatives trading, as dated futures are often illiquid and spot markets are less desirable for short-term trading.
Traders who have thrived in the perps market cite deep liquidity, low trading fees, and high margin efficiency as the primary reasons for their success. However, they also express concerns over funding rates, which can add up quickly and eat into profits.
To understand the appeal of perps, it's essential to consider the perspective of both retail and institutional traders. Lucas Krenn, a derivatives trader at STS Digital, notes that perps are the 'plumbing underneath everything' his firm does, particularly when trading altcoins. He emphasizes that dated futures are often too illiquid to be useful, making perps the go-to choice. Similarly, independent trader Kenneth Ong highlights the benefits of perps for retail traders, including better fills, lower fees, and the ability to hold both long and short positions simultaneously.
One of the significant advantages of perps is their ability to provide price discovery around the clock, rather than being limited to traditional market hours. This has been particularly evident in the tokenized oil market, where perps have allowed traders to react quickly to news events. The always-on nature of perps has also enabled the creation of new trading opportunities, such as tokenized equities, which can be traded without the need for traditional share ownership.
Despite the many benefits of perps, traders are also wary of the funding rate, which can be a significant burden for those holding positions for extended periods. Unlike dated futures, which have a fixed interest rate, perps have a funding rate that changes over time and is typically charged every eight hours.
This can make it difficult for traders to quantify and hedge their exposure, leaving them vulnerable to unexpected changes in the market. The funding rate can be particularly problematic for traders who hold positions for long periods, as it can potentially balloon into a significant expense. Furthermore, the lack of a built-in mechanism to lock in the funding rate means that traders remain exposed to the floating rate, which can be a major cause for concern. In addition to the funding rate, traders also need to be aware of the risks associated with liquidations, which can occur when the market moves against them.
However, as Krenn notes, the problem is not with perps themselves, but rather with the crypto exchange margin model, which can socialize losses onto winners. The key distinction is between facing a proper clearing house with a mutualized default fund and an exchange that socializes losses onto the winners.
In terms of risk, Krenn offers an interesting insight: being long is often the structurally safer side, as positive funding can be easily arbitraged away. However, when the funding rate is negative, the arbitrage becomes more complicated, and the gap between perp and spot prices can persist.
This can lead to extremely negative funding rates, which can be difficult to hedge. Ultimately, perps have democratized futures trading by providing access to a leveraged market with low fees and high margin efficiency. However, they also come with unique pain points, such as volatile funding-rate exposure, which can be difficult to quantify and hedge.
As Krenn puts it, 'Until there is a liquid dated curve in crypto, the whole market is carrying an interest rate exposure it cannot price and cannot hedge.' In the meantime, funding is the tax everyone pays for easy access to this leveraged market.